This article is intended to inform the reader of general legal principles applicable to the subject area. It is not intended to provide legal advice regarding specific problems or circumstances. Readers should consult with competent counsel with regard to specific situations.

By Douglas Cushing
June 2010

2010 may be a good time for estate and succession planning by gifting. In fact, it may be a point in time that will disappear in the near term as a desirable time to make gift transfers. There are three reasons which create this window of opportunity, assuming that the transfers are done correctly.

The first opportunity is the silver lining in the cloud of the great recession we are enduring. Values remain depressed on most assets, so a greater share of any asset base can be transferred by gift. Second, interest rates continue to be low, designed to assist a restart of the economy; thus calculations that factor in present values and rates of return will produce a lower value on an asset. Third, the potential inclusion of pending legislation to reenact the federal estate tax, which may severely limit or eliminate entirely discounts on intrafamily transfers.

Depressed Asset ValuesThe negative impact of the recession has reverberated from the housing market to equities, to commercial real estate, and to virtually every other form of wealth or business ownership. For the owner of a privately held company, value reductions can allow a significantly higher percentage of ownership to be transferred. That opportunity is based purely on the raw asset values, for if marketability and minority discounts are factored in, the opportunities are enlarged.

Low Present Value and Rates of ReturnThe continued effort by the federal government to limit interest rates contributes to further support for present gifts. As returns fall based on lower rates, or cap rates change to diminish value multiples, a gift again can transfer a higher percentage of the ownership, whether looking at purely annual exclusions or more substantial transfers. Rates will rise if inflation occurs, as is feared, which will generate a value boom (or boomlet perhaps) but current transfers can be very effective.

Pending Estate Tax LegislationThe pending legislation to reenact the federal estate tax may provide the final incentive for action now. That legislation comes about because the Senate failed before the end of 2009 to approve any measure in line with the House action that had approved continuation of the 2009 exemption level and rates on estates after January 1, 2010. Without that agreement, technically the estate tax does not exist right now, although it may be enacted retroactively. The significance for gifts in that legislation is that the Internal Revenue Service has waged a serious effort over the past several years to contest discounting the values based on minority ownership and marketability claims. In many instances, the courts have rejected the IRS position. The discounts, which can range to up to 50 percent of the value of an asset, significantly reducing the gift tax liability. A business owner who can take advantage of those transfers may transfer a much higher portion of its business. The bills now in the Senate will deny such a discount if the beneficiary of the transfer is not actively involved in management or the operation of the business. Given the expanded use in recent years of limited liability companies or limited partnerships, business owners have employed much greater fractional ownership arrangements and taken much higher use of such beneficial discounts.

The last point to note is that the IRS has in recent years prevailed in a number of cases in greatly increasing the tax hit, or applying a gift tax at all, when the transfer is not sequenced correctly. One failing comes from transfers of assets into an entity such as an LLC, followed immediately by a transfer of an interest in that entity. The IRS has prevailed in many cases on the argument that this really is an indirect gift of the asset, to which a minority or marketability discount may not be nearly as significant as it would be for a privately held LLC. In some cases even when everything is done in the right sequence, if done pursuant to a clearly identified plan, the IRS has argued that the step transaction doctrine, through which the IRS seeks to compress multiple steps into a single event for the tax collectors benefit, would deny the discounting of value increasing the tax payable. Essentially one must not be casual as to attending to the details of putting together a family or business planning strategy.

Significant gift transfers are often very difficult for owners of a business or senior members of a family to make, especially emotionally. This calendar year may be one time when the potential benefits, offset by the risk of a retroactive legislative step, may afford a unique opportunity before the economy surges, interest rates rise, and long-term values escalate. Transfers at this point may successfully boost the ability to move ownership and control of a business operation or a family investment portfolio to another generation.